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Sector update: Home Improvement - Morbi visit: Improving but yet not out of the woods!

We present key takeaways of our interaction with various tiles manufacturers in Morbi, Gujarat (Simpolo, Varmora, SunHeart, Qutone, Antique Johnson, etc). Morbi players expect 7-10% volume growth in FY19E for the industry versus 3-5% growth in FY18. Their optimism is based on their view that 1) residential real estate is seeing revival in pockets, with RERA impact waning, 2) momentum in low-cost housing projects is picking up, 3) exports are continuing to strengthen and 4) compliance levels of smaller and unorganised players continue to improve with the implementation of GST/eWay bill. While most players do not see any scope for further price reduction in GVT, wall tiles could face some pressure. Manufacturers do not expect much increase in gas price from the current level, as they are already at elevated levels. Overall, the industry is mildly upbeat on FY19E versus FY18.

Key Takeaways:

• Real estate recovery on the horizon: A real estate revival appears to be taking hold, albeit in certain pockets. Morbi players believe disruptions post RERA implementation are mostly behind, with newer large-scale projects expected in the years ahead. Also, on the ground activity in low-cost housing could fuel demand for mass-market tiles in the near to mid-term. However, mid-to-upscale real estate (including premium) remains sluggish, given the high inventory levels. Commercial real estate too is fueling demand for tiles, as the space continues to do well.
• Industry expects 7-10% volume growth in FY19E: The tiles industry witnessed 3-5% volume growth in FY18, mainly supported by exports; domestic players, however, saw weak performance during the year (flat to negative). Morbi tile manufacturers are eyeing volume growth from exports in the near term after a tepid FY18 (caused by GST disruptions, lingering effect of demonetization in early FY18 and weak demand); tiles players now expect 7-10% volume growth in FY19E (supported by mass/mid-market products, and exports). Players expect double-digit volume growth in Q4FY19E/FY20E.
• Pricing corrections behind, but hikes may be difficult: GVT prices corrected sharply, as a large number of new units opened up in Morbi. However, given the rise in fuel prices, most GVT capacities are running at cost (zero margin) and Morbi players do not expect further price correction in this space (at the most 1-2% correction). Wall tile prices may see some correction (prices have been steady), as 35-40 new units are expected to come up soon. However, high competitive intensity in the domestic market and weak (albeit improving) demand may impede price hikes in the immediate future for players. Morbi-based players see superior realizations only on improving mix.
• Hopeful for fuel prices to come off: Akin to crude prices, gas prices too have risen sharply over 2017-2018; post Gujarat state election, gas prices have been hiked twice (currently at ~Rs36-37/scm). Continuing rise in crude prices makes its unlikely that gas prices may cool off anytime soon, although most Morbi players are hopeful of a correction (most expect global gas prices to reduce during summer). High gas price is a key incentive for ~60% of ceramic tiles players in Morbi to use coal-based gasifiers (coal is available in cash and offers 45-60 day credit period).
• Unorganized industry feeling the heat, but more needs to be done: Although the shift from unorganised to organized has been slow, most large Morbi players we interacted with indicated that unorganized industry participants are considering shifting to full tax compliance, fearing government crackdown. The recent eWay Bill regulations would go a long way in leveling the field for organized tax-compliant players and come as a positive for the overall Morbi industry in the long run. However, the industry feels that in the near-term, strict surveillance measures are needed to implement the GST/eWay Bill in its true spirit.

We remain positive on the organized tiles space, as we see immense growth potential for the industry as a whole (only ~11% of Indian households used tiles as flooring material per Census 2011), notwithstanding our weak near-term growth outlook. Large players like Kajaria Ceramics (KJC) and Somany Ceramics (SOMC), with their strong brand equity, robust product portfolio and distribution reach, and asset-light balance sheets, would be strong beneficiaries of this growth runway. We maintain our Outperformer rating on both stocks.